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A new era for collateral

Friday, 03 June 2016   (0 Comments)
Posted by: Author: Jeanette Maree
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Author: Jeanette Maree (FirstRand Banking Group)

Certain changes to the TAA mean that certain non-cash collateral will now be treated in the same way as pledged collateral. 

The 2015 Taxation Laws Amendment Bill (2015 TLAB) heralds a new era for collateral. With effect from 1 January 2016, a dispensation covering securities transfer tax (STT), income tax and capital gains tax (CGT) will be introduced to ensure that certain non-cash collateral placed by way of outright transfer is treated the same for tax purposes as pledged collateral.

Without such a dispensation, the adverse tax implications of placing non-cash collateral by way of outright transfer make it prohibitive. This is because both the placement and the return of non-cash collateral constitute disposals for tax purposes, with either income tax or CGT implications, depending on the orientation of the parties. Furthermore, both the placement and the return of shares as collateral trigger STT.

As a result of the adverse tax consequences of outright transfer of collateral, business found itself in the invidious position where collateral could only effectively be placed by way of cash or pledge. In a world of rising cost of funding, cash collateral has become an expensive collateral option, pushing parties towards non-cash options. Due to the fact that the pledge of non-cash collateral does not involve the change in beneficial ownership of the collateral assets, no tax consequences (albeit STT, income tax or CGT) ensue. However, the legal limitation of pledged collateral in that it cannot be on-plegded, results in large amounts of non-cash collateral being trapped in pledge. This not only negatively impacts market liquidity, but results in parties who take pledged collateral and are themselves required to on-collateralise, generally being forced into using expensive cash collateral. This increased cost of collateral inevitably adds to the cost of the underlying transactions, resulting in our local financial sector being less competitive than the offshore equivalents. 

The absence of a tax dispensation for the outright transfer of non-cash collateral not only impacts market liquidity and adds to the cost of collateral, but also adversely affects banks’ ability to meet their ever-increasing regulatory requirements under Basel III, which are aimed at ensuring the overall financial stability of the South African financial sector. Following the global financial crisis, unsecured funding has been identified as a source of systemic risk and, increasingly, funding takes place on a secured basis. Furthermore, with the introduction of the Basel III Liquidity Coverage Ratio and Net Stable Funding Ratio requirements and the South African Reserve Bank’s Committed Liquidity Facility requirements, banks will have to maintain ever larger collateral pools. Banks see the ability to transact on a secured basis with local and foreign banks as being critical to fulfil their cash and liquidity management requirements in a prudent and efficient manner. Mechanisms to seamlessly monetise assets (by way of an appropriate collateral dispensation) would offer banks the ability to withstand far greater liquidity shocks and maintain an improved liquidity range.

The gist of the collateral dispensation under the 2015 TLAB is that where listed shares are placed as collateral for an underlying debt, neither the placement nor the return of the collateral will trigger STT, income tax or CGT, provided such collateral arrangement does not exceed 12 months. The amendments very closely mirror the existing securities lending arrangement dispensations contained in the Securities Transfer Tax Act No 25 of 2007 (the STT Act) and the Income Tax Act No 58 of 1962 (the Income Tax Act). To this end, a definition of "collateral arrangement” has been introduced in section 1 of the STT Act, which is referred to in section 1 of the Income Tax Act; an STT exemption has been included in section 8 of the STT Act; section 9C of the Income Tax Act has been expanded to ensure that the utilisation of shares for purposes of a collateral arrangement does not interrupt the three-year safe harbour; section 22 has been amended to disregard the placement and return of shares under a collateral arrangement for purposes of income tax; and paragraph 11(2) of the Eighth Schedule to the Income Tax Act has been extended to include the placement and return of shares under a collateral arrangement as a non-disposal for CGT purposes. The effect of these amendments is that, despite the transfer of beneficial ownership, collateral under a "collateral arrangement” is effectively disregarded for STT, income tax and CGT purposes. This is consistent with the tax treatment of pledged collateral, where STT, income tax and CGT are disregarded due to the fact that there is no transfer of beneficial ownership of pledged collateral.

The proposed dispensation is welcomed by the financial sector, as it goes a long way toward resolving the collateral constraints experienced by, among others, banks and the securities lending industry with regard to utilisation and on-posting of collateral.

But does it go far enough? From a market liquidity perspective, it facilitates the potential release of a relatively small amount of collateral currently immobilised under pledge — namely listed shares where the collateral arrangement does not exceed 12 months. In addition, for banks to put the dispensation to use in meeting their ever-increasing regulatory requirements, it is essential that they be able to access both shares and debt instruments over periods in excess of 12 months without adverse tax consequences. The Banking Association of South Africa will be lobbying National Treasury on behalf of the financial services industry for an expanded dispensation in order to ensure that banks are able to meet their Basel III regulatory requirements in a tax neutral manner.

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This article first appeared on the May/June 2016 edition on Tax Talk.



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